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Here's Why You Should Keep Adding REITs to Your Portfolio

The overall performance of the REIT industry in 2017 has not been awe-inspiring amid macroeconomic uncertainty in the nation and restrained trading activity. However, a number of asset categories have stood out and generated solid returns, at times even above the broader market.

Moreover, due to the presence of favorable market conditions, these REITs have enough scope to excel in the future. This reinstalls our confidence and encourages us to focus on individual market dynamics that play a crucial role in determining the performance of REITs.

Furthermore, instead of worrying over the December rate hike, one needs to shift attention to the better outlook provided by the Fed this time, in terms of GDP growth for 2018, a positive revision in projected inflation and expectations of a solid job market. This is because REIT business usually buoys up on a stepped-up economy and job scenario.

Also, the growing importance of the industry over the years is quite evident. It has carved a niche for itself through the creation of the exclusive headline sector for real estate under the Global Industry Classification Standard (GICS) in 2016.

Further, investors' faith in this sector and their willingness to pour money into it is increasing, which is apparent when we look at the industry’s capacity to raise capital from the market.

Amid all this, the time is now apt to explore the industry and scoop up big gains.

Technological evolution is changing the dynamics of the real estate market and substantially driving up demand at a number of asset categories. For example, the e-commerce boom has hugely affected retailers’ business model, causing a decline in mall traffic and keeping retail REITs on tenterhooks.

On the other hand, demand for another set of REITs ticks up right from the time one uses smartphones, tablets or computers for a purchase. This is because as demand is placed, the order is transmitted through cell towers and processed at data centers. Finally, the order is fulfilled through the industrial/logistics facilities and delivered at the doorstep.

Now, REITs happen to own many of these cell towers, data centers and logistics facilities. Therefore, without the offering of this critical infrastructure, the e-commerce value chain simply cannot sustain.

Along with making purchases online, an increasing number of people are consuming digital content. Going by numbers, per a forecast from Cisco, from 2016 to 2021, global Internet video traffic and mobile data traffic are estimated to witness a CAGR of 31% and 46%, respectively.

The estimated growth rate for the markets of artificial intelligence, Internet of Things, autonomous vehicle and virtual/augmented reality are also anticipated to remain robust over the next five to eight years. Therefore, along with an improved outlook for economic growth, all these only make us hugely optimistic about extensive growth in demand for space at cell tower and data-center REITs.

Further, amid economic expansion, e-commerce development and heightened urbanization, companies are shifting their strategy to services like same-day delivery and other options. This is propelling demand for distribution facilities near population centers, which not only help in lowering delivery time but also reduce cost of delivery.

In fact, according to a report from Prologis Inc. (PLD - Free Report) , for a given level of revenues, online retailers require three times the distribution center space compared with traditional retailers. As such, demand from the e-commerce sector has been escalating and per a report by Jones Lang LaSalle Inc. (JLL - Free Report) , in third-quarter 2017, this sector accounted for nearly 25% of total U.S. leasing demand compared with 14.7% in the previous year.

This is offering significant impetus for growth to industrial REITs. Further, a healthy manufacturing environment, a recovering economy and job market gains are likely to drive demand from other sectors besides e-commerce. So shareholders of such REITs have sufficient reasons to rejoice.

Over the past several quarters, several issues have cropped up in the retail REIT market with consumers preferring online platforms over in-store purchases, resulting in store closures and bankruptcies. These have affected the share price of several major retail REITs in the past year.

In fact, retail REITs are putting in every effort to boost productivity of malls, by trying to grab attention from new and productive tenants, and disposing the non-productive ones. Amid the ongoing changes in consumer behavior, retail REITs have been avoiding heavy dependence on apparel and accessories. Rather, these companies are expanding dining options, opening movie theaters and offering recreational facilities. Eventually, such strategic measures are likely to boost traffic.

Moreover, retail REITs are intending to expand their portfolio of shops, which comprise service-based industries such as saloons and spas, personal fitness, and medical practices. Such properties enjoy frequent customer traffic, are Internet-resistant, and drive dependable traffic as a result.

The U.S. apartment market reported stable rent growth, while occupancy remained healthy in recent quarters. In fact, per a study by the real estate technology and analytics firm, RealPage, Inc. (RP - Free Report) . U.S. apartment rents increased at a modest rate of 2.5% in 2017. Further, national apartment occupancy came in at 95.1% at the end of fourth-quarter 2017, remaining unchanged from the prior year.

Further, with apartment starts displaying a slowdown in 2017, supply issues are likely to abate to quite an extent toward the end of 2018 and in 2019. In addition, there is solid chance of pent-up demand as the number of doubled-up households remains high.

Moreover, with a significant salary differential between college graduates and high-school graduates, college enrolment is set to increase. This will likely drive demand for residential units that are leased by student housing REITs. Also, there is pent-up demand for new, purpose-built student housing properties that have better amenities than old, outdated housing. Further, supply remains manageable.

Apart from these, student housing REITs have solid opportunities to excel in the coming years as demand is emanating for on-campus developments from universities that are facing state budget cuts and low funds, and are incapable of developing or renovating the aging housing properties. And on-campus housing usually enjoys full occupancy.

With economic improvement and recovery in the job market, healthy growth in demand for office spaces is expected to continue. This is because, as the economy revives, business grows. So corporate sectors seek expansion and rent more space to accommodate increased workforce.

While higher construction with increased completions might moderate the pace of growth in the primary markets, secondary markets are likely to excel with increased population and growth in employment.

In case of hotel REITs too, an improving economy, growth in employment and rise in wages are likely to drive demand for hotels. Moreover, with a slowdown in supply growth, fundamentals are expected to be in favor of the hotel landlords.

Mixed-Use Developments Gains Popularity

Mixed-use developments have also gained in popularity in recent years. Such developments lower the distance between housing, workplaces, retail businesses, and other amenities and destinations. Hence, such developments enable companies to grab the attention of people who prefer to live, work and play in the same area — a trend that drove development in several other cities in the U.S. In recent years, retail REITs like Regency Centers Corp. (REG - Free Report) and Federal Realty Investment Trust (FRT - Free Report) also directed their investments toward such projects.

Aging Population to Drive Demand for Healthcare REITs

Demand for healthcare real estate is expected to increase considerably on favorable demographics. This is because the senior citizen population is growing at a faster rate than other adults calling for a greater healthcare needs. Along with an aging population and cost containment, less expensive delivery settings and new technologies, demand for medical office buildings as well as urgent-care facilities is growing.

Moreover, university-based life science real estate has grabbed attention and health care REITs are making decent investments in this segment. Such investments help to capitalize on growing health-care-driven research and development, supported by top-tier research universities.

Dallas, TX-based Ashford Hospitality Prime is a REIT focused on investing in high RevPAR full-service hotels and resorts located predominantly in domestic and international gateway markets. It has a Zacks Rank #2 (Buy). Moreover, Ashford Hospitality Prime has exceeded the Zacks Consensus Estimate in two out of trailing four quarters, with an average beat of around 3%.

LTC Properties, based in Westlake Village, CA, is a healthcare REIT that focuses on investments in seniors housing and health care properties mainly through sale-leaseback transactions, mortgage financing and structured finance solutions including mezzanine lending. It has a Zacks Rank of 2. Also, the stock has seen the Zacks Consensus Estimate for 2017 being revised upward over the past 60 days.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Los Angeles, CA-based Rexford Industrial Realty is focused on acquisition, ownership and operation of industrial properties situated in Southern California infill markets. Rexford has a Zacks Rank of 2. It has a long-term growth rate of 7.7%.

Headquartered in New York, Outfront Media is a leading provider of out-of-home advertising space in key markets throughout the United States and Canada. It has a Zacks Rank of 2 and has exceeded the Zacks Consensus Estimate in two of the trailing four quarters with an average beat of 2.9%.

Check out our latest REIT Industry Outlook here for more on the current state of affairs in this market from an earnings perspective.

Note: All EPS numbers presented in this write up represent funds from operations (“FFO”) per share. FFO, a widely used metric to gauge the performance of REITs, is obtained after adding depreciation and amortization and other non-cash expenses to net income.

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